We recently sat down with Harin de Silva, Ph.D., CFA, President and Portfolio Manager at Analytic Investors, sub-advisor of the 361 Long/Short Equity strategies, to discuss low-volatility equity investing. Specifically, why a dynamic approach to investing is necessary given potential fluctuations in factors that can be present in global equity markets.
361 Capital: Aside from identifying a stock as a low-volatility candidate, what other risks need to be addressed when investing in the low-vol space?
Harin de Silva: First, whether a stock’s historical returns, and its standard deviation, are actually representative of that stock going forward. A stock with a low beta may not remain so because of changes to its business or environment.
An example of this can be found in the aftermath of the 2011 Japanese tsunami. A number of historically low-beta utilities were gravely affected when their nuclear power plants began emitting radiation—clearly, the companies’ risk characteristics changed significantly. Here, active management could have come to the rescue.
361 Capital: Let’s take a look at the opposite end, at the high beta side. Growth stocks are typically high-beta issues. That includes a lot of tech stocks. Are there other companies with growth characteristics in the high-volatility camp today? Are we seeing different high-vol stocks today versus, say, five or ten years ago?
Harin de Silva: Tech is not as high beta as it used to be. A part of that is almost definitional, because tech in any cap-weighted index has dramatically increased over the last five years. As the portion of tech in the index gets larger and larger, the beta of tech keeps falling because you’re measuring the beta against itself.
And they’re not tech in the same way, either. People call Netflix a tech stock as if it were Facebook, Amazon or Apple, but Netflix is really a Disney competitor in some ways. Its beta has actually come down in the past five years.
At the opposite pole, the beta of financial stocks has risen dramatically since the ’07 credit crisis. Oil stocks, too, have definitely become more risky, so oil’s beta has definitely gone up.
361 Capital: What about the middle ground between low- and high-volatility? Is there any reason for a long/short low-vol strategy to hold stocks in the middle of the volatility spectrum?
Harin de Silva: Volatility is just one dimension of portfolio construction. If you’re building a diversified portfolio, you don’t want to hold high-beta stocks on your long side and you don’t want to hold low-beta stocks on your short side. You want the opposite in both cases. Stocks in the middle of the beta spectrum may be desirable for their other attributes. You may, for example, find a stock with a beta of 0.98, but it may have good value characteristics, a lot of quality and price momentum as well. Those traits make the stock useful from a total return standpoint. Even though it has a near-market beta, that stock has merit on the long side of the portfolio. Similarly, a stock with a high P/E and poor growth characteristics could be a candidate for the short side despite having a beta near 1.
Learn more about factors in the continuation of our Q&A with Harin de Silva, Ph.D.: The Role of Factors in Portfolios >